Factor Investing: building a portfolio based on market factors
This lack of discernment can lead to disappointment, as high return expectations clash with inadequate research.
This article sheds light on a more structured approach – factor investing – to streamline the investment process and avoid falling into the trap of labelling the stock market as a mere ‘gambler's place’.
What is Factor Investing?
Factor investing involves attributing the returns of your equity portfolio to specific factors such as value, quality, volatility, and market capitalisation.
These factors act as persistent and well-documented drivers of asset class returns, offering investors insights into expected returns and aiding in seeking outperformance or managing risks effectively.
With the accessibility of exchange traded funds (ETFs), factor investing is no longer confined to the elite, presenting a balanced mix of passive and active investment management.
Understanding Long-term Drivers of Equity Returns
Value Factor
This factor indicates that stocks with low P/E multiples or high earnings yield tend to offer higher returns, especially during stock market recoveries.
Momentum Factor
Strong price momentum effects have been observed in various asset classes globally, indicating that past winners continue to outperform losers.
Growth Factor
This factor gauges a company's potential based on historical or projected growth rates, signalling potential strong future stock price performance.
Quality Factor
The quality factor is based on complex accounting information, focusing on companies with little divergence between accrual and cash earnings.
Size Factor
Smaller companies, such as midcaps and smallcaps, are believed to outperform larger peers over the long run due to untapped markets and growth
